***Q2 Client Update***
The second quarter of 2025 was one of those rare and very interesting periods on more than one front. However, the quarter really played out as the first few weeks of April and then the rest of the quarter. The world came into Q2 acutely focused on what President Trump deemed “Liberation Day”, that day when the administration’s trade policy was going to free the U.S. from its dependence on much of its international trade as well as level the playing field. Peter Navarro was the face of the administration and a pit bull on trade. Three months ago, I offered that just watching which person the administration paraded around would tell you all you needed to know about the tariff plan and markets.
I don’t think I am exaggerating to say that there was much anxiety around the world heading into April which was exacerbated when the tariff plan turned out to be roughly double what was originally forecast. That end number was approximately $660 billion or 2% of GDP. And as many would imagine, the global financial markets plunged as only half of the tariff plan was priced in. And to reiterate, I still hate protectionist policies like tariffs regardless of politics as they are antithetical to free markets and capitalism.
Remember folks, companies are like the Marines. They adapt and they adjust. Unlike the Marines, companies struggle with unexpected, short, sharp shocks out of the blue, like COVID. The unintended benefit of the unexpectedly large tariff plan was that it gave corporate America cover for revenue, earnings and forecast shortfalls. In fact, a good number of companies removed forward guidance and hid from the public.
However, as Stephen Sondheim famously once wrote, “a funny thing happened on the way to” economic doom and a market crash. The administration stuck Navarro in the closet and Treasury Secretary, Scott Bessent whom I said was bullish for the markets, became the public face right near the low. The stock market bottomed, reversed sharply higher and ended the quarter up more than 10% with the economic data not accommodating the pervasive negativity set by the bears. All in all, if you fell asleep on January 1st, 2025 and woke up on June 30th, the S&P 500 gained 6% during the first six months and you would have been pleased with the results.
Looking at the quarter that was, an awful lot took place. Donald Trump’s Elon Musk-led Department of Government Efficiency (DOGE) apparently concluded their work. The war in Gaza waged on as did the war in Ukraine. Rumored ceasefires in both did not come to fruition, at least not yet. Israel unilaterally attacked Iran and softened its defenses’ underbelly enough for the U.S. to launch a surgical strike on Iran’s nuclear capabilities which reportedly set the Iranians back several years.
Crude oil, which bottomed at $55 in mid-quarter, soared to $78 during the turmoil, only to settle back to $65 by the end of June. Those with gray hair or lost hair may recall very different market responses to geopolitical news out of the Petro-region in the Middle East. With the U.S.’ energy independence, global markets are no longer hostage to saber rattling.
Elsewhere, the UCONN women’s basketball team regained national glory by adding their 12th championship to their storied list, running through March Madness like Sherman through Atlanta. Less importantly, the NBA and NHL crowned their champions. In golf, Rory McIlroy captured The Masters and completed the elusive grand slam.
Economically, after negative GDP growth in Q1, the economy bounced back in Q2 in spite of a chorus of Armageddon forecasts. For several years post-COVID, the economy has shown signs of being ripe for a mild recession. Whether it has been the inverted yield curve where short-term interest rates are above long-term ones or the Leading Economic Indicators or inflation or the Sahm Rule, resilient is the best word to describe our economy.
I remember penning a few pieces that perhaps COVID made some semi-permanent structural changes to the economy which rendered some tried and true indicators as less reliable. Of course, we won’t know for many years and modern-day recessions have always been accompanied by exogenous events like Iraq invading Kuwait, 9-11, the Great Financial Crisis and COVID. So, even though the pump may have been primed for recession, there thankfully hasn’t been one of those types of events to tip the economy.
In early Q2, an awful lot of people were forecasting that tariffs were that exogenous event and that a collapse that could rival 2008 was unfolding quickly in real time. These Chicken Little cries coincided with one of the most dramatic three-day stock market plunges in the modern era. At that time, I was firm that the mini crash was nothing more than the 10%+ correction I had been looking for by July 4th. Of course, the magnitude was higher than I originally thought. We also saw some of the most indiscriminate selling in history which we later learned was driven by the supposed smart, institutional money and not the retail investor. The “little guy” was actually buying the collapse while the big money was reacting emotionally, hiding under their desks in the fetal position sucking their thumbs.
Having been in the business since 1988 with many notebooks of observations over the years, I was dumbfounded how many people bragged about liquidating their portfolios as they “knew” the markets and economy were about to crash. Emotional selling in the heat of a plunge rarely pays off. We watched that happen with millions of investors during the COVID Crash. They may feel better for a day or few, but a bottom is usually not far behind. In the tariff case the low was imminent.
Over the years, some folks have asked me why we don’t sell more securities when a decline is underway, and I opine that it has further to go. First, we are quantitative model driven and we follow what our models say. And yes, of course, we can alter our models if we don’t like how they behave, but that does defeat their purpose in the first place. Second, as I like to explain, if we or our models weren’t smart enough to take action before the decline, I certainly do not want to compound a problem with another problem.
As I already mentioned, the financial markets were all over the place in Q2. At the stock market’s worst, the S&P 500 was down 12% in early April for Q2, -18% year-to-date and -21% from peak to trough. It also rebounded 26% from its trough to June 30th. That is the epitome of volatility, and the Federal Reserve stood pat which was not a good thing. While European and other international stock markets led, the relative gains were muted compared to Q1. Elsewhere, bond yields began and ended the quarter in almost exactly the same place. Gold rallied from $3100 to $3300 as the dollar plunged even further than we saw in Q1.
The cryptocurrency asset class soared from its early April low right to quarter-end, further solidifying my stance that it is anything but a hedge against anything. Bitcoin, Ethereum and like are full, risk on assets that correlate best with the NASDAQ 100 on steroids. Before folks think I am anti-crypto, it’s quite the opposite if you recall my comments in late 2022 and early 2023. At that time, after a massive decline to 13,000 on Bitcoin, I repeatedly stated that I could not be more bullish on the asset class. It was a golden opportunity to buy. That being said, after its melt-up and ongoing surge, I could not ever invest new money until it falls hard again, which history says it will.
At this point in the report, I usually write about my barbell strategy for investing. If you picture a barbell from the gym, there is a long, thin bar with big weights on both ends. Think of those weights as our conservative strategies and aggressive ones, the exact proportions do not matter yet. In theory, your money would have higher weights to conservative and aggressive strategies, especially if you are in or very close to retirement, and lower allocations to the middle of the road strategies.
This barbell approach has also worked very well with monies being transferred in from 401K and 403b plans as those pre-packaged plans rely heavily on bonds for the more conservative approach and do not account for interest rates rising. Additionally, their aggressive choices do not usually reward the risk taken. If you would like to learn more about the barbell approach, we can set up a meeting, call, or Zoom.
Every now and then clients and prospective clients ask me where I invest my own money. As you know I am a huge proponent of eating one’s cooking. In other words, if I have high conviction in our strategies to recommend that clients invest, I should have the same conviction with my own money. I have 95%+ of my investable assets as well as my family’s in our strategies.
Within our strategies, I have always been an aggressive investor, and I have trained my family to follow suit. That’s my personal objective and risk tolerance. As such, I have the vast majority of our money in our various aggressive strategies. I also have small pieces in a number of other strategies that do not fall into the aggressive category. When our strategies perform poorly for a month or quarter, which they have and will again in the future, I try to add money to those.
As I discussed throughout Q2, the tariff tantrum mini crash in early April should be the worst of it regarding financial market reaction. As the days, weeks and months advance, tariffs should have less and less impact. Eventually, there will be a major tariff announcement that is completely ignored by the markets. Then we will know that tariffs have been fully priced in, and the markets have moved on to something else.
Economically, we should see modest GDP growth in Q3 as the effects from One Big Beautiful Bill are still yet to be seen. I have been critical of a number of elements of the legislation, but I do think it will unleash a wave of deregulation which will give the economy a tailwind beginning later this year and into 2026, a mid-term election year.
While inflation may print a few warmer months, I do not believe we will see any sustained levels above 3% until the other side of the next recession. Although the employment market is weaker than it was in 2024 it is still not weak. Much to my disappointment, the Federal Reserve will stand pat in Q3, even though they have plenty of cover to cut rates once or twice. As you know, this is pattern behavior for the Fed. For the best and brightest bankers on earth, they seem to habitually miss the mark in real-time.
Turning to the financial markets, Q3 looks to be on the quiet side unless some exogenous event hits. Risk on markets like equities and crypto have come very far and very fast. I expect at least a 2-5% pullback for stocks in Q3 and perhaps 10% in the crypto space. Of course, timing is everything and greed and giddiness have replaced fear and despondency. However, markets often overshoot so what should happen may take longer to unfold.
The bond market remains in a trading range which has nothing to do with what the Fed does or does not do. Long-term rates are set by the markets, and the Fed “usually” follows them. I think the 10-Year is buyable on any spike over 5%, but I will start looking more closely if yields get above 4.70%. The 2-Year is signaling that the Fed needs to cut 0.50% as it has all year. Gold has been consolidating nicely, and weakness still looks like a buying opportunity in Q3. The U.S. dollar has basically been stair stepping down all year. It is very oversold and should at least bounce in Q3. While crypto may blow off to the upside in the short-term, I do think there is a 10%+ correction coming sooner than later and likely this quarter.
Please remember some of the opportunities at hand. We do our best to harvest tax losses in taxable accounts as we did in April. If you have IRAs, you should strongly consider ROTH conversions with the goal of having as much as possible in ROTHs during retirement. ROTHs are the single best account structure ever invented and far too few people take advantage of them. And I equally love ROTH 401Ks for your employer sponsored plan, especially for folks under the age of 50.
Updating your retirement projections is an invaluable tool, especially during periods of market weakness. Remember, we account for 10% declines, 20% declines and multi-year bear markets in our projections. Stock market declines reinforce our projection process. It is those projections that matter most over the long-term, not the day-to-day market volatility which causes discomfort to so many investors.
Please remember that while I publish regularly on the blog and speak freely in the media, our non-emotional, quantitative models dictate how each strategy invests, not my personal feelings or opinions. It is sometimes difficult when one group of models reduces exposure while another group remains in full steam ahead mode. I just keep my head down and follow what we built as best I can.
Please continue to share your feedback, positive and negative. Investing is a marathon not a sprint and the long-term future continues to look very, very bright. We look forward to sharing that with you over the coming years. And I am always interested in meeting, whether it is to create or update retirement projections on your financial situation, review the strategies in your portfolio, run social security analysis’ on when and how to file for the best benefit, discuss your estate or even smaller transactional-type issues like securing a mortgage or weighing insurance. Again, here is the link to my calendar to schedule a meeting in the office, call, Zoom meeting or Skype. https://schedulewithpaul.as.me/
Thank you for the privilege of serving as your investment adviser!
Sincerely,
Heritage Capital, LLC
Paul Schatz AIF
President
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